Unpaid Taxes, Un-filed Taxes, and Outstanding Tax Obligations
One of the ticking time bombs that can explode after a divorce is finalized is the issue of unpaid or unfiled joint or individual taxes. If you and your spouse file joint taxes during the marriage and you have any concern that your spouse may have underreported their income, or that they may have any outstanding tax liabilities you should protect yourself in the settlement agreement with language which indemnifies you from any action brought by a taxing authority against you. This situation arises often times when one spouse owns a small business and their record-keeping, reporting, and payment has been sub-par. It also occurs when one spouse is in the habit of paying taxes on an installment basis during the course of the marriage. A similar situation arises when spouses file jointly and there is a joint tax obligation outstanding. A post-divorce tax audit can also lead to an assessment of penalties and interest. In all of these situations allocation has to be made as to who will pay the taxes (including any penalties and interest) to the taxing authorities.
Innocent Spouse Relief, Separation of Liability, and Equitable Relief – IRS Form 8857
In a situation where there has been an understatement or underpayment of tax and one spouse has been in charge of “handling” the taxes while the other spouse has merely been a signatory to a joint return, the innocent spouse may be able to use the innocent spouse rules promulgated by the IRS to shield them from any liability. Briefly stated, the IRS allows a spouse or ex-spouse who would otherwise be jointly liable for an understatement or underpayment of tax to shield themselves from the other spouses tax liabilities. A spouse seeking to protect themselves can claim that they are an innocent spouse if they are eligible under IRS rules. They can also request a separation of tax liability, where each spouse’s tax liability is calculated separate and apart from the other spouse’s. Finally, they may be entitled to equitable relief from the tax liability if they meet the IRS’ criteria. In order to be considered for any of the above three types of relief the taxpayer must file IRS Form 8857.
Business Tax Debt
Oftentimes a husband and wife own a business where one spouse runs the business on a day-to-day basis, and the other spouse is an officer, director or member (in the case of an LLC) in name only. The non-participant spouse was named in the incorporation papers as a formality, even though they have no real role in the business. Years go by, and the non-participant spouse and the spouse running the business day-to-day forget that the non-participant spouse is formally an officer of the business. If a divorce later takes place the non-participant spouse’s liability as an officer or director of the business has to be accounted for and addressed. If taxes are not paid on a timely basis the spouse who signed as an officer or director and then forgot about their formal connection to the business can still be dragged into any post-divorce mess if the participant spouse failed to pay taxes or file tax returns on a timely basis. These issues need to be sorted out and dealt with before the divorce is completed.
The importance of indemnification language in your settlement agreement cannot be overstated. Where there is the potential for a post-divorce tax obligation the indemnification language should be very clear as to which party will be responsible for paying any delinquent taxes (including interest and penalties). The agreement should also address indemnifying the innocent spouse from any expenses connected with unresolved or unpaid tax liabilities including indemnification for attorneys fees and other costs that may have to be incurred.
If you have questions about how divorce impacts joint and individual tax obligations of married couples contact me at 201-731-3086 (toll-free at 844-431-3380). You can also reach me using the email contact form. My law practice operates statewide in the state of New Jersey. I have been representing clients, primarily in the northern counties of New Jersey, including: Bergen, Hudson, Essex, Passaic, Union and Middlesex counties, for over 20 years. Whether your initial contact with me is via telephone or email the consultation is free of charge.